In south central Manitoba, a couple we’ll call Herb and Cathy, both 64, are looking ahead to their future. They have farmed grain for more than two decades and have two children, a son age 40 and a daughter, 42. Each has a career off-farm and neither has an interest in returning to the family farm.
Herb and Cathy have concentrated on producing wheat and canola, but they were late to the business and therefore incurred high costs for equipment. Added to that, there were years of crop failures. They scraped by on the modest payouts of crop insurance. Nevertheless, they have substantial farm losses they carry forward.
Farm Financial Planner put the problems Herb and Cathy face to Don Forbes and Erik Forbes of Don Forbes & Associates/Sterling Mutuals in Carberry, Manitoba. The couple should be able to retire with no debt, says Don Forbes. He notes that recently, after two years of exceptional yields and good commodity prices, they have eliminated much of their debt and decided to quit and retire. Their grain inventories, machinery and income from their farm corporation will use up all their loss carry-forward credits, making all income tax-free.
Herb and Cathy have a farm corporation with a half interest held by a silent partner. Along with the land, inventory and machinery, they have three quarter sections of farm land they own personally and other machinery and inventory they own personally.
Best bet: sell all remaining grain inventory in the 2015 tax year or at least as much as possible. The income from sale will be covered by the existing carry forward capital losses, about $247,000, rendering most of that income tax-free, Erik Forbes says.
The sale of two of three quarter sections of personally owned farm land this year will probably generate large capital gains, but all of those gains will be tax exempt via the farm land capital gains tax exemption, Erik adds.
In 2016, they can sell any remaining machinery and take a capital gain on the sale of the last quarter section of land. If they get $200,000 from sale and apply $126,000 of book value and $74,000 of recaptured depreciation, they will have no tax exposure, Forbes notes.
Herb and Cathy are each eligible for $813,600 of capital gains exemption on their personally owned farm land. Although the entire three quarter sections will be eligible for $1,627,200 capital gains exemption, the Alternative Minimum Tax will apply. A few thousand dollars of AMT will be due for 2015 but can be recaptured in future tax years, Don says.
Herb and Cathy each have about $10,000 of Locked In Retirement Accounts from years past when they worked off-farm. They can unlock the accounts for 2015. All of Herb’s LIRA and half of Cathy’s can be taken out, subject to provincial legislation. If put into cash accounts, the money can be withdrawn as needed. Cathy can use up her money relatively quickly to use up her AMT credit after the 2015 tax year. If she does not use up her AMT credit in 2016 or 2017, it may not be useable, as the couple’s future income will be relatively modest.
If the couple sells $29,000 of inventory in 2015 and $69,000 of land in each of 2016, 2017 and 2018 and pays taxes of $3,200 for 2015 and then $13,000 in each of the three following years, they will have remaining cash of $193,800. The total gain on the land sale will be $173,000, which will be subject to tax on half the gain — $13,000 will be the tax payable in 2016 to 2018 inclusive, Don estimates.
There is an alternative to taking taxable dividends. That is to issue shareholder bonuses which are a 100 per cent expense to the farm corporation. This would be advantageous to Herb, though Cathy, with a lower tax bracket, would not benefit as much, Erik notes.
In retirement, the couple’s retirement income would be a total of $1,010 from the Canada Pension Plan, full Old Age Security benefits of $1,140 in total and investment income from capital released from the farm of $1,740. That adds up to $3,590 each month before tax or $43,080 annually before tax. Their tax would be negligible, Don says.
What sort of retirement will $3,590 a month buy? If the couple allocates 25 per cent of income for rent, $898 a month, they will get at most a modest apartment outside of a major city. The remaining $2,692 would allow $200 a month for car expenses, $800 for food, $200 for clothing, $300 a month for travel, $200 for entertainment, $200 for charity and gifts, $300 for health related costs and $492 for discretionary spending. Comfortable, yes, but not lavish.
Assuming that after sale of farm property, including the farm house, the couple has $375,000 to invest, the question arises — how to do it? The usual answer is mutual funds, yet over a long term, average mutual fund fees of 2.5 per cent on equity funds add up to 25 per cent over ten years and a whopping 50 per cent over 20 years, Don Forbes estimates.
The remaining issues concern end of life. Chances are that Herb and Cathy will have a few good decades together, but if they persist in their frugal ways and have moderate success with their investments, they are likely to pass with substantial residual assets. Their children will be in their sixties in this scenario and contemplating retirement, Erik Forbes observes.
In their wills, Herb and Cathy may want to contemplate a generational shift in their assets with bequests to good causes, to their grandchildren, or to more distant family members. The cost of discussions with their lawyer and accountant of the tax implications of generational shifts of property will be money well spent, Forbes says.
“This couple can go from today’s burden of debt to a future of relative prosperity with a new problem of wealth administration,” Don Forbes says. “They need to be ready for that change.”